Entrepreneurship|A Start-Up That Makes Loans Based on Loyalty When Banks Will Not

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A Start-Up That Makes Loans Based on Loyalty When Banks Will Not

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Beezy's Cafe in Ypsilanti, Mich. “Loyalty capital,” in the form of customers who pledged to spend $475 a year at the restaurant, helped the owner get a business loan.CreditCreditLaura McDermott for The New York Times

To the residents of Ypsilanti, Mich., Beezy’s Cafe looks like a thriving business. The six-year-old restaurant and coffeehouse draws crowds for breakfast and lunch, employs 16 people, has a trail of glowing Yelp reviews for its “hippy vibe” and “super friendly” staff, and recently extended its hours to serve dinner on Fridays and Saturdays.

But to banks, it’s a risky venture with little appeal. Beezy’s is only intermittently profitable, and most of the cash it generates goes straight back into keeping it running. Bee Roll, the cafe’s founder and owner, has no collateral to offer for a loan or credit line: She rents her home and leases the restaurant’s space and some of its equipment. Nearly everything in the cafe — including the eclectic local art on its walls — is scavenged, borrowed or bartered.

The most valuable thing Beezy’s has is its loyal customers. Now, in a novel lending experiment, it is testing a new system for quantifying customers’ devotion and turning it into an asset that can be monetized.

The cafe is the first guinea pig for ZipCap, a fledgling start-up in San Diego with a new lending model it calls “loyalty capital.” The aim is to offer small retailers like restaurants, boutiques and service providers access to low-interest loans financed by investors with a vested interest in supporting a local economy.

At the heart of ZipCap’s system is the idea that successful merchants have a network of repeat customers with strong connections to their favorite neighborhood businesses. Such buyers, the theory goes, can be encouraged to give those businesses a predictable sales stream — one that, if it is documented and tracked, will give lenders a reasonable picture of a business’s ability to repay a loan.

ZipCap’s merchants start by recruiting an “Inner Circle” of customers who pledge to spend a set amount of money in a fixed period of time. ZipCap then tallies up those pledges and allows businesses to borrow against a portion of it. To be eligible for loans, companies must have been in business for at least two years in the same location and must enroll at least 100 Inner Circle members. Participants pay ZipCap a monthly fee of either $99 or 2.5 percent of their Inner Circle transactions, whichever is lower.

At Beezy’s, Ms. Roll signed up 130 Inner Circle members. Each committed to spend $475 a year. In March, she became ZipCap’s first borrower, taking out a $10,000 loan with a 12-month repayment schedule and an annual percentage rate of 3.99 percent.

That rock-bottom rate is far below those available through credit cards or the growing field of alternative small-business lenders that offer financing to entrepreneurs who do not qualify for traditional loans. (Ms. Roll said two local banks had declined her credit applications.) Ms. Roll said that for her, ZipCap’s biggest appeal was the link it helped forge between her business and its most devoted customers.

“I want access to cheap money so I can keep doing great things for the community,” she said. “When I started explaining the pledge concept, people were like, ‘This is going to help you? Great, I’m in!’ It really makes it clear how vital their support is to us. There’s trust, and an ongoing relationship.”

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Bee Roll, left, the owner of Beezy's Cafe, working in the kitchen. “When I started explaining the pledge concept, people were like, ‘This is going to help you? Great, I’m in!’ ”CreditLaura McDermott for The New York Times

Evan Malter, ZipCap’s founder and chief executive, considers the relationship aspect of ZipCap’s system just as important as the “cheap money” part. “We want people to see the impact they have on their local economy,” he said. “When a customer feels as though they have contributed to the success of a business, they have a greater bond to that business and are more compelled to visit.”

ZipCap’s unusual lending model, Mr. Malter said, emerged from his desire to fix flaws in other small-business financing options, particularly interest rates so high that he considers them predatory. It is also the result of trial-and-error experimentation.

Mr. Malter initially set out to create a very different venture: an equity crowdfunding site that would help business owners raise capital from their customers. But the more he learned about how neighborhood retailers operate, the less he liked that idea. Razor-thin margins leave little room for investor profit, he realized, and merchants’ accounting systems are often messy and ad hoc. “How a pizza shop owner is running the business is not something anyone can do due diligence on, much less the crowd,” he said.

So he started over, focusing on the issues that often prevent small-business owners from obtaining affordable loans: lack of collateral and low (or nonexistent) profitability. “By using customer loyalty as collateral and an asset, we’re creating an accounts receivable stream for the kinds of businesses that otherwise have none,” Mr. Malter said.

The question on which the entire model hinges, though, is how reliable customers’ spending pledges turn out to be. ZipCap has 10 Michigan businesses in various stages of a pilot program and is tracking their Inner Circle follow-through rates. At Beezy’s, five months in, 117 members — 90 percent of the group — are on pace to fulfill their pledges. Nine have already done so and renewed for another $475 commitment. One member dropped out, and 12 are falling short of their target.

To succeed, ZipCap will need to sell both merchants and investors on its loyalty capital concept and prove that it is an effective way to underwrite loans. Robert Foster, a veteran of the impact investing industry and a board member of the Social Venture Network, says the start-up is one he is keeping a close eye on.

“This is a challenging pool of applicants to lend to,” Mr. Foster said. “You’re essentially an unsecured creditor. ZipCap believes that social pressure is enough to keep people doing the right thing, to keep customers fulfilling their pledges and borrowers paying back their loans. The $1 million question for me is: Is that glue really strong enough?”

Greg Bennett, an investment analyst with the VilCap Investments, a fund that focuses on early stage, mission-driven enterprises, described ZipCap with the quip: “Evan’s doing his best to find every single George Bailey in the country.”

It’s a risky, idealistic approach, but in areas with the right combination of civically minded consumers, entrepreneurs and investors, it could take hold, Mr. Bennett said. The Detroit metropolitan area, where ZipCap is focusing now, is an ideal testing ground.

When Stewart W. Beal, a 12-year Ypsilanti resident who lives four blocks from Beezy’s, heard about the Inner Circle program, he and his wife immediately signed up. He’s a fan of the cafe’s chicken club sandwiches, and an even bigger fan of the role Beezy’s plays in the neighborhood. Mr. Beal, who runs a real estate development and construction firm, frequently holds business meetings at the cafe, and his wife stops by often with their 2-year-old daughter. He said he was delighted to see a once-vacant building turn into a local hub.

“I’m an entrepreneur,” Mr. Beal said. “I’ve borrowed money before, and at times I’ve struggled to borrow money. So I got this right away. I think it could work very well for businesses like this that are supported by the community.”

A version of this article appears in print on , on Page B5 of the New York edition with the headline: A Start-Up That Makes Loans Based on Loyalty When Banks Will Not. Order Reprints | Today’s Paper | Subscribe